The purpose of this assignment is to solidify your understanding on the applications of the cost of capital topics. The scores of this assignment will help in assessing the following learning goal of the course:"students successfullycompleting this course will be able to estimate and interpret the cost of capital of a firm based on different capital structures."

STOP! Before you proceed with the homework read the instructions below, review the grading rubric, and refer to the subsequent example of how to complete each problem. If you do not follow the instructions as outlined, you will likely be penalized (even if you arrive at the correct solution).

Instructions:

You are required to use a financial calculator or spreadsheet (Excel) to solve 10 problems (provided on page 4) related to the cost of capital. You are required to show the following three steps for each problem (a sample problem and solution is provided for guidance):

1. (i)Describe and interpret the assumptions related to the problem.
2. (ii)Apply the appropriate mathematical model to solve the problem.
3. (iii)Calculate the correct solution to the problem.

1

Homework Grading Rubric

For each problem, your responses will be assessed using the criterion listed in the rubric below.

Not submitted (0 pts)

Does not meet expectations (1 pts)

Meets expectations (3 pts)

Exceeds expectations (5 pts)

No attempt made or no effort to show relevant steps in solving the problem

The appropriate variable to be solved for is not identified and/or no relevant assumptions are explicitly stated

The relevant information is not correctly identified and applied to the appropriate mathematical model and/or an incorrect model is identified

Calculations are only partially attempted and are incomprehensive resulting in an incorrect solution

The appropriate variable to be solved for is correctly identified but only a few of the relevant assumptions are explicitly stated

The relevant information is correctly identified and applied to the appropriate mathematical model

Calculations are attempted but minor errors result in an incomprehensive and incorrect solution

The appropriate variable to be solved for is correctly identified and all relevant assumptions are explicitly stated and contribute to a deeper understanding of the material (e.g. each TVM variable is identified with appropriate sign (+/-), cost of capital adjustments are made for non-annual debt payments)

The relevant information is correctly identified and applied to the appropriate mathematical model and information is portrayed in a way that contributes to a deeper understanding of the material (e.g. a correctly developed timeline of cash flows is created, graphs are drawn and labeled appropriately)

Calculations are fully attempted and are sufficient to arrive at a comprehensive and correct solution

2

Sample Problem #1:

Sample Problem and Solution

A company is expected to pay a $3.50 dividend at year-end, the dividends are expected to grow at a constant rate of 6.50% a year, and the common stock currently sells for $62.50 per share. The before-tax cost of debt is 7.50% and the tax rate is 40.00%. The target capital structure consists of 40.00% debt and 60.00% common equity. What is the company's WACC if all equity is from retained earnings?

Solution:

1. (i)Describe the assumptions related to the problem:
2. The problem assumes the dividends of the company will grow at 6.50% forever and next periods dividend will be $3.50; a tax rate of 40.00% is also assumed for the firm.
3. (ii)Apply the appropriate mathematical model:
4. The cost of equity is based on the dividend growth model: